Namibia: Staff Report for the 2006 Article IV Consultation

This 2006 Article IV Consultation highlights that with generally prudent macroeconomic policies, Namibia has enjoyed robust growth, moderate inflation, and strong external surpluses. Growth is expected to increase to 4½ percent in 2006, after 4¼ percent in 2005, owing in part to a recovery in diamond production. Rising oil prices and interest rates have not yet noticeably affected activity. Public debt is poised to rise again over the medium term in light of an expected decline in custom union (SACU) receipts and an increase in spending to address Namibia’s development needs.

Abstract

This 2006 Article IV Consultation highlights that with generally prudent macroeconomic policies, Namibia has enjoyed robust growth, moderate inflation, and strong external surpluses. Growth is expected to increase to 4½ percent in 2006, after 4¼ percent in 2005, owing in part to a recovery in diamond production. Rising oil prices and interest rates have not yet noticeably affected activity. Public debt is poised to rise again over the medium term in light of an expected decline in custom union (SACU) receipts and an increase in spending to address Namibia’s development needs.

I. Background

1. Supported by generally prudent macroeconomic policies, Namibia has enjoyed robust growth, moderate inflation, and strong external surpluses (Figure 1). Although other sectors have shown steady growth, reliance on minerals has made economic performance volatile. Little progress has been made in broadening the country’s economic base and raising its long-term growth potential. In addition, poverty and unemployment are widespread, and a high rate of HIV/AIDS infection undermines investment in human capital.

Figure 1.
Figure 1.

Namibia: Major Macroeconomic Challenges

Citation: IMF Staff Country Reports 2007, 012; 10.5089/9781451828436.002.A001

Sources: Namibian authorities; UNAIDS report 2006; Namibian Household Survey 2004; and Fund staff estimates.1 The severely poor and poor are defined as those who spend more than 80 percent and 60 percent, respectively, of total income on food.
Text Table 1.

Namibia: Macroeconomic Indicators

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Source: WEO/WETA database.

Average for sub-Saharan African countries.

For Namibia, data are on fiscal-year basis (April 1-March 31).

2. Macroeconomic performance has held strong, helped by a recovery of diamond production in 2006 (Figure 2). Rising oil prices and interest rates have not yet noticeably affected activity. Though rising, inflation is expected to remain moderate. The current account has a comfortable surplus, thanks to record diamond exports and a surge in customs union (SACU) receipts. However, continued outflows of capital to South African financial markets have kept international reserves relatively low. With tax collections buoyant, the 2005/06 fiscal deficit fell to ¾ percent of GDP, though spending on wages and subsidies exceeded budget ceilings. Consistent with the peg to the rand, the BoN has matched recent interest rate increases by the South African Reserve Bank, lifting rates by 2 percentage points in 2006.

Figure 2.
Figure 2.

Namibia: Selected Economic Indicators

Citation: IMF Staff Country Reports 2007, 012; 10.5089/9781451828436.002.A001

Sources: Namibian authorities; and Fund staff estimates and projections.

II. Policy Discussions

A. Overview

3. The 2006 Article IV consultation was streamlined. Building on the detailed analysis of the 2005 Article IV mission, this year’s discussions focused on: (i) private sector development, emphasizing competitiveness and financial sector issues; (ii) the level of international reserves; and (iii) medium-term fiscal policy.

4. The authorities saw the streamlined format, as well as Fitch’s recent confirmation of Namibia’s investment grade rating, as acknowledgement that their macroeconomic policies are prudent. Nonetheless, they emphasized Namibia’s major developmental needs and reiterated their concern that Namibia’s classification as a middle-income country hinders their ability to tap concessional financing.

B. Private Sector Development

5. The authorities have begun reforms that should help raise Namibia’s growth potential. Particularly noteworthy are the recent launching of education reform—to narrow the skills mismatch in the economy—and the strong implementation of the HIV/AIDS strategy, which envisages universal coverage of antiretroviral treatment by 2010. The newly created Anti-Corruption Commission (ACC) represents a milestone toward improved governance; however, the mission stressed that the ACC would need adequate funding if it is to fulfill its mandate.

6. Indicators provide a mixed view of competitiveness, though the indicators and the current level of the REER do not suggest cause for immediate concerns (Box 1). Staff estimates of the equilibrium REER suggest that a small overvaluation in 2005 was largely reversed in 2006 as the exchange rate depreciated. Nonetheless, there are challenges to Namibia’s future competitiveness. In particular, its traditionally strong current account surplus is projected to decline drastically over the medium term, as SACU revenues are expected to fall and mineral exports to plateau.

Namibia’s Competitiveness

Traditional measures, such as the REER, do not suggest that Namibia has a competitiveness problem (Figure 3). However, Namibia’s REER has remained relatively unchanged since independence while South Africa’s has depreciated. This is partly because average annual inflation has been about 1 percent higher in Namibia than in South Africa (although the inflation rates have recently converged). Also, Namibia’s peg to the rand and the large trade weight of South Africa dampen movements in Namibia’s REER.

Figure 3.
Figure 3.

Namibia: Competitiveness

Citation: IMF Staff Country Reports 2007, 012; 10.5089/9781451828436.002.A001

Sources: IFS, WEO, Namibian Authorities, and Fund staff calculations.1/ Values for September and October 2006 are estimated from the nominal exchange rates, and for the remainder of 2006 values are assumed to be constant.

Though labor productivity appears to have grown more in Namibia than in its neighbors during 2000-05, productivity levels are still generally below South Africa’s. In mining and manufacturing, where productivity has risen rapidly, Namibia compares favorably with South Africa, but productivity growth has lagged in the service sectors. For example, the productivity level in wholesale trade is estimated to be 40 percent lower in Namibia than in South Africa, and productivity in government services is 30 percent lower. Moreover, the level of government productivity has been falling relative to South Africa. This may reflect Namibia’s large civil service.

Other indicators give a mixed view of Namibia’s competitiveness. Since independence, Namibia’s terms of trade have been volatile though with no clear trend. The trade deficit has averaged 5 percent of GDP and the current account surplus 4½ percent. Though they are also volatile, these figures do not show any worsening trend. In contrast, Namibia’s share of world trade has steadily fallen. Qualitative indices (see below) also suggest room to improve competitiveness.

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Text Figure 1.
Text Figure 1.

Real Effective Exchange Rate: Deviations from the Equilibrium Level, 1980-20061/ (Percent of the equilibrium level)

Citation: IMF Staff Country Reports 2007, 012; 10.5089/9781451828436.002.A001

1/ Equilibrium level estimated through single-country regressions using standard fundamentals. While consistent with the results from panel estimations for a large sample of African countries, the small data size and concerns about data quality before independence in 1990 warrant cautious interpretation. The equilibrium level in period t is a 3-year average for t-1, t, and t+1.

7. The authorities concurred with the need to boost private sector activity. They plan to continue their dialogue with the business community to identify and remove obstacles to private sector activity, such as with respect to the streamlining of business licensing and property registration. The mission suggested that measures be taken in two key areas. First, there is a need to facilitate the entry of skilled foreign workers to bridge the skills gap until education reform produces enough qualified local workers. The authorities recognized that transferring skills from abroad is important but stressed their intention to balance the entry of skilled workers against the objective of developing local capacity and improving the employability of Namibian workers. Second, Namibia should keep labor markets flexible and labor costs in check. The authorities’ decision not to implement the 2004 amendments to the Labor Law, which would have raised labor costs, is therefore commendable, but it is not clear whether a revision of these amendments, to be submitted to parliament in early 2007, will allay concerns about excessive vacation days and sufficiently address the cumbersome procedures for terminating nonperforming employees.

8. Further modernizing the financial system would also help develop the private sector (Figure 4). Little has been done to broaden the reach of the financial system to rural and low-income customers. There is a particular need for affordable financial products for those customers and a reduction in the high banking charges. To address these problems, the authorities are consulting with the industry on developing a financial sector charter. Aside from accessibility, the charter aims to enhance the role of formerly disadvantaged groups, similar to efforts undertaken in South Africa.

Figure 4.
Figure 4.

Namibia: Financial Sector Developments

Citation: IMF Staff Country Reports 2007, 012; 10.5089/9781451828436.002.A001

Sources: Bank of Namibia; NAMFISA; South African Reserve Bank; IFS; and Fund staff calculations.1/ Based on Namibian IIP data, except for direct investment liabilities with South Africa, which are based on South African IIP data. This reflects the status of the current reconciliation exercise.In 2005, 63 percent of total short-term debt liabilities with South Africa was owed by commercial banks.

9. The regulatory and supervisory framework for the financial sector is being upgraded. On banking supervision, the BoN has made great strides toward complying with the Basel Core Principles. In particular, it has clarified the methodology for measuring market and country risks and has begun implementing consolidated and risk-based supervision, as the 2005 FSAP recommended. There has been less progress on supervision of nonbank financial institutions (NBFIs). The authorities stressed that overhauling the regulatory and supervisory framework for NBFIs and reorganizing their supervisory agency, NAMFISA, represented daunting tasks but concurred that remaining deficiencies needed to be addressed expeditiously. The mission also urged speedy adoption of the NAMFISA Act, which would close gaps in the legislative framework for nonbank supervision. Finally, current indicators suggest that the banking system remains generally sound and profitable. Against the backdrop of the continued strong growth in credit to the private sector, the mission recommended that the authorities further explore the underlying causes for the more recent rise in nonperforming loans as well as monitor their evolution going forward.

Text Table 2.

Namibia: Financial Sector Indicators

(percent)

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Sources: Bank of Namibia; and Fund staff estimates.

The improvement in the NPLs ratio in 2004 was due to refocused loan collection efforts, reclassifications of loans, and write-offs by one commercial bank. The slight deterioration in the NPLs ratio in the second quarter of 2006 stemmed from commercial bank loan exposure to fishery and mining companies.

C. International Reserves

10. The authorities are firmly committed to the exchange rate peg to the South African rand and further economic integration in southern Africa. This could include the possibility of a monetary union under the Common Monetary Area (CMA).1 The peg is consistent with Namibia’s close trade and financial links with South Africa and enjoys strong public confidence and support.

Text Figure 2.
Text Figure 2.

Namibia: Trade and Financial Ties to South Africa, 2005 (Percent of total)

Citation: IMF Staff Country Reports 2007, 012; 10.5089/9781451828436.002.A001

Source: Namibian Central Bureau of Statistics.

11. The mission recommended the authorities take steps to increase reserves. While reserves are twice the monetary base, they are uncomfortably low relative to imports and short-term debt. More reserves would help insure against adverse shocks to trade and capital flows. However, limited domestic investment opportunities have left private investors (particularly NBFIs) with little choice but to channel their assets to the more sophisticated South African financial markets. The 2005 FSAP suggested that creating greater domestic investment opportunities would be key to building reserves and attracting capital.

12. The mission advocated several specific market-based strategies to help strengthen reserves. These include promoting asset securitization, open market purchases of foreign exchange, and, if need be, creating a positive interest rate differential vis-à-vis South Africa. It also supported the authorities’ decision to borrow internationally—the BoN contracted a syndicated one-year loan of US$50 million in August 2006 to establish a market presence—which benefited gross reserves; however, the mission emphasized that future borrowing should have longer maturities to reduce rollover risk. It strongly advised against regulatory measures to stem capital outflows, such as requiring Namibian NBFIs to invest in domestic assets which is unlikely to be effective, could carry higher risk, and undermine NBFIs’ soundness.

13. The authorities concurred with the need to build reserves and generally welcomed the mission’s proposals. They stated that their efforts to strengthen liquidity management, along the lines of Fund TA, should help them purchase foreign exchange in the market. They also plan to discuss with financial institutions means to create domestic investment opportunities, including the securitization of assets, such as mortgages. However, they did not exclude taking regulatory steps to keep savings within the country to help finance its development needs.

D. Fiscal Policy

14. After substantial fiscal consolidation in the two preceding years, the authorities loosened their underlying fiscal policy stance in 2006/07 (Figure 5). Namibia will receive a temporary windfall in SACU revenues of about 5 percent of GDP this fiscal year due to buoyant imports (resulting from past appreciation of the rand) and residual distributions from the transition to a new SACU revenue-sharing formula.2 A supplementary budget submitted during the mission devotes a portion of this windfall to deficit reduction, resulting in a small budget surplus for 2006/07. However, the bulk of the windfall is earmarked for additional spending. In light of projected medium-term fiscal pressures, the mission noted that it would have been desirable to devote more of these one-off receipts to reducing public debt, as was done with receipts from the partial privatization of the mobile phone service provider MTC. While public debt is projected to fall to around 26 percent of GDP by 2007/08—within striking distance of the authorities’ long-run fiscal rule target of 25 percent of GDP—it is expected to rise again over the medium term. This rise reflects the projected sharp drop in SACU receipts—to some extent related to trade liberalization—and Namibia’s substantial development needs which require increased outlays for health, education, poverty reduction, and infrastructure.

Figure 5.
Figure 5.

Namibia: Fiscal Issues

Citation: IMF Staff Country Reports 2007, 012; 10.5089/9781451828436.002.A001

Sources:Namibian authorities and Fund staff calculations.1 The fiscal stance is represented by changes in the overall balance (including grants) as a percent of GDP, while monetary conditions are measured by an index of the weighted average of the real policy interest rate and real effective exchange rate, the weights being 50:50. The windfall in SACU receipts is estimated as the difference (as a percent of GDP) between the projected value for 2006 and the trend for 2000-05
Text Table 3.

Namibia: Central Government Operations

(Percent of GDP)1

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In Fund staff definition, which places extrabudgetary spending financed by external loans under expenditure and the overall balance. The authorities exclude this figure in their budget presentation.

The revenue windfall is estimated as the difference (as a percent of GDP) between the projected value for 2006 and the trend for 2000-05.

15. While recognizing the medium-term fiscal pressures, the authorities do not yet have a strategy to address them. Considering Namibia’s macroeconomic circumstances, the mission recommended that the authorities aim to keep public debt on a downward trajectory, by running primary surpluses in most years. This would require adopting an effective medium-term strategy to improve revenue collections in a sustainable manner and reorient spending away from personnel expenditures and subsidies to parastatals toward priority sectors. Small primary surpluses would be consistent with preserving macroeconomic stability while allowing Namibia to address its development needs and make faster progress toward achieving the Millennium Development Goals, MDGs (Figure 6). There is also room to improve the efficiency of public expenditure, such as for education where outcomes have been below expectations and given impetus to education reform.

Figure 6.
Figure 6.

Namibia: Progress Toward Selected Millennium Development Goals1

Citation: IMF Staff Country Reports 2007, 012; 10.5089/9781451828436.002.A001

Source: World Bank, http://www.developmentgoals.org; and United Nations, http://unstats.un.org.1 Progress is measured against a linear projection between the 1990 level and the MDG.2 Due to lack of data, actual data for 1990 is assumed to be for 1992.

16. Regarding revenues, the authorities pointed to strong increases in income and VAT collections which they attributed to having outsourced audits to the private sector. The mission welcomed the increased collections and urged the authorities to develop a comprehensive strategy to durably enhance tax administration, as Fund TA has recommended. The strategy should include building audit capacity, establishing a large taxpayer office, and adopting a risk-based strategy for VAT refunds. The authorities reiterated their commitment to reform tax administration eventually but said they plan to rely in the short run on audit outsourcing to safeguard tax collections.

17. Past efforts to contain the wage bill have been ineffective. Namibia has one of the highest levels of personnel expenditure in Africa, accounting for 15 percent of GDP and two-fifths of all government spending. Due to ineffective controls,3 line ministries have been able to circumvent a hiring freeze, leading to an 8 percent increase in the number of civil servants in 2005/06 and a doubling since independence in 1990.

Text Figure 3.
Text Figure 3.

Namibia and Sub-Saharan Africa: Central Government Wage Bill, 2004

(Percent of GDP)

Citation: IMF Staff Country Reports 2007, 012; 10.5089/9781451828436.002.A001

18. The mission strongly recommended that the authorities draw up a strategy for the appropriate structure, quality, and remuneration of the civil service. The strategy should reduce staff through attrition, eliminate redundant government functions, and identify staffing needs and reallocate staff among ministries. Staff also recommended that growth of personnel expenditures be limited to the inflation rate.

19. The authorities, while recognizing that the wage bill is unsustainable, consider civil service reform politically difficult, given the country’s high unemployment rate and narrow economic base. They stressed that creating private sector jobs would allow a decline in the number of civil servants in the long run.

20. On the other hand, the authorities stressed their determination to reform state-owned enterprises (SOEs) and reduce their drain on the budget. The recently-adopted SOE Governance Act, if implemented successfully, could lay the foundation for enhancing the government’s ability to monitor SOEs, improve their governance and performance, and lessen the need for subsidies which have averaged 2 percent of GDP for the last five years. Staff recommended several measures to make the legislation an effective tool. These included recommendations that: (i) the new Governance Council focus on a broad strategic vision, delegating operational functions to a new agency; (ii) boards of directors be selected through a transparent process; and (iii) SOEs and private firms operate on a level playing field.

21. The mission held discussions with the authorities, as well as with a coalition of NGOs and church leaders, over efforts to reduce poverty. The authorities agreed with the mission that more determined efforts are needed to reduce poverty but that any such efforts should not compromise fiscal stability. In a meeting with the coalition on their proposal for a basic income grant (BIG)—a cash grant to be paid to all Namibians under the age of 60 irrespective of income—the mission agreed on the importance of addressing Namibia’s widespread poverty. The coalition criticized the staffs concerns in last year’s staff report on the BIG’s affordability, which in their view had hampered their efforts to advance the proposal. The mission accepted the coalition’s view that the BIG’s gross costs could be lowered on a net basis through income tax payments by high-income earners. Nonetheless, it reiterated that the BIG’s net costs would remain substantial and difficult to accommodate within a sustainable fiscal framework, given other public spending priorities (including health and education). It pointed to alternative conditional cash grant schemes being implemented, quite effectively and at lower cost, in Latin America which could serve as an example for Namibia.4

III. Staff Appraisal

22. With its generally prudent macroeconomic policies, Namibia has enjoyed macroeconomic stability but also faces many economic and social challenges. These include high rates of poverty, unemployment, and HIV/AIDS infection. In the long run, raising Namibia’s growth potential and safeguarding its external competitiveness will be key to addressing these challenges. This can best be achieved by creating an environment conducive to private sector activity and implementing measures aimed at a more efficient use of public resources, complemented by policies to protect the most vulnerable members of society.

23. Recent reforms bode well for addressing these challenges, but more needs to be done to enable the private sector to be the engine of growth. The launching of education reform, the strong implementation of the HIV/AIDS strategy, the creation of the Anti-Corruption Commission, adoption of the SOE Governance Act, and the ongoing consultations on a financial sector charter are commendable first steps. More efforts are needed to facilitate skills transfer from abroad, ensure that labor markets are flexible and less costly, expedite the licensing and registration of businesses, and further strengthen the regulatory and supervisory framework for the financial sector, especially NBFIs.

24. At the same time, Namibia should preserve its strong record of macroeconomic stability. This record has been based on overall prudent fiscal policies and a credible link of the Namibia dollar to the South African rand. Nonetheless, the authorities should consider market-based measures to boost international reserves while resisting regulatory means to keep Namibia’s large savings at home.

25. Recent progress in fiscal consolidation is welcome, but medium-term fiscal pressures will make it hard to keep public debt on a downward trajectory. Without determined efforts to shore up revenues and reduce personnel expenditures and subsidies to parastatals, the government will be hard pressed to address Namibia’s development needs. To sustain tax collections, the government should strengthen its audit capacity, establish a large taxpayer office, and better administer the VAT. Faced with declining SACU receipts and other expenditure demands, it will be crucial to develop a strategy to reform and reduce the size of the civil service. While the new SOE Governance Act could enhance the government’s handle on the parastatals sector and limit its drain on the budget, the government should develop a strategic vision for the sector, which may include restructuring and privatizing selected SOEs. This would ensure a more efficient use of scarce public resources and foster growth.

26. Staff recommends that Namibia remain on the standard 12-month consultation cycle.

Table 1.

Namibia: Selected Financial and Economic Indicators, 2003-11

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Sources: Namibian authorities; and Fund staff estimates and projections.

Figures are for the fiscal year, which begins April 1.

Table 2.

Namibia: Balance of Payments, 2003-11

(Millions of U.S. dollars)

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Sources: Namibian authorities; and Fund staff estimates and projections.

Namibia will become a net exporter of electricity in 2011, when electricity production related to the Kudu gas project is expected to be fully operational.

Southern African Customs Union.

Gross foreign assets of the Bank of Namibia, converted to U.S. dollars.

Table 3.

Namibia: Central Government Operations, 2004/05-2011/12

(Millions of Namibia dollars)

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Sources: Namibian authorities; and Fund staff estimates and projections.

"Overall balance" reflects externally financed project spending (except for roads) that is not channeled through the state account. "Overall balance excluding extrabudgetary spending" excludes such spending and thus corresponds directly with the authorities’ concept.